Nouriel Roubini is a professor of economics at New York University’s Stern School of Business, chairman of Roubini Global Economics and former senior advisor to White House Council of Economic Advisors.

All posts by Nouriel Roubini

No one can pretend to know whether Spain is illiquid or insolvent without gauging the size of the black hole that is the country’s banking sector. The Spanish government is finally starting to do this: Bankia and other banks are reportedly set to receive a capital injection from Madrid. With the Spanish economy contracting sharply and with unemployment soaring, it was inevitable that the government had to bail out the banks. But this only deals with one piece of the puzzle. Without growth, the Spanish sovereign will need a bailout as well. Read more

A myth is developing that private creditors have accepted significant losses in the restructuring of Greece’s debt; while the official sector gets off scot free. International Monetary Fund claims have traditional seniority, but bonds held by the European Central Bank and other eurozone central banks are also escaping a haircut, as are loans from the eurozone’s rescue funds with the same legal status as private claims. So, the argument runs, private claims have been “subordinated” to official ones in a breach of accepted legal practice.

The reality is that private creditors got a very sweet deal while most actual and future losses have been transferred to the official creditors.

Greece’s private creditors should stop complaining and accept the deal offered to them this week. They will take some losses, but those losses are limited and, on a mark-to-market basis, the debt exchange offers them a potential capital gain. Indeed, the fact that the new bonds are expected to be worth more than the old bonds suggests that this PSI exercise has further transferred losses to Greece’s official creditors.

The reality is that most of the gains in good times – and until the PSI – were privatised while most of the losses have been now socialised. Taxpayers of Greece’s official creditors, not private bondholders, will end up paying for most of the losses deriving from Greece’s past, current and future insolvency. Read more

For the last three years the world’s major economies – the US, eurozone and China – have been living up to the infuriating euphemism so beloved of policymakers – “kicking the can down the road”. They have been avoiding the tough decisions that are required to address their fundamental economic, financial and fiscal problems.

The US has postponed fiscal consolidation and structural reforms; the eurozone has been in denial of the fact that some of its member states are insolvent; and China has persisted in its export-led growth model where savings are too high and consumption too low. In all cases political constraints have led leaders to avoid the short-term costs of decisions that will yield benefits only over the medium term.

But these delaying tactics will become more difficult in 2012. Some eurozone members may need to coercively restructure their debts; China’s economy may come close to a hard landing; and US markets in the US may become more concerned about the ongoing political gridlock.

By 2013 or even earlier, a perfect storm of a double-dip recession in the US, a disorderly scenario in the eurozone and a hard landing in China could materialise. Read more

It is increasingly clear that Italy’s public debt is unsustainable and needs an orderly restructuring to avert a disorderly default. With public debt at 120 per cent of gross domestic product, real interest rates close to five per cent and zero growth, Italy would need a primary surplus of five per cent of gross domestic product – not the current near-zero – merely to stabilise its debt. Soon real rates will be higher and growth negative. Moreover, the austerity that the European Central Bank and Germany are imposing on Italy will turn recession into depression.

The country’s public debt needs to be reduced now to at worst 90 per cent of GDP from the current 120 per cent. This could be done by offering investors the choice to exchange their securities either for a par bond or for a discount bond that has a face value reduction of 25 per cent. The par bond would suit banks that hold bonds to maturity and don’t mark to market. There should be a credible commitment not to pay investors who hold out against participating in the offer – even if this triggers the payment of credit default swaps.

But even a debt restructuring would not resolve Italy’s problems of lack of growth and outright recession, lack of competitiveness and a large current account deficit. Tackling those requires a real depreciation that may well demand the eventual exit of Italy and other member states from the euro. Read more

With interest rates on its sovereign debt surging well above seven per cent, there is a rising risk that Italy may soon lose market access. Given that it is too-big-to-fail but also too-big-to-save, this could lead to a forced restructuring of its public debt. That would partially address its “stock” problem of large and unsustainable debt but it would not resolve its “flow” problem, a large current account deficit, lack of external competitiveness and a worsening plunge in gross domestic product and economic activity.

To resolve the latter, Italy may, like other periphery countries, need to exit the monetary union and go back to a national currency, thus triggering an effective break-up of the eurozone.

The eurozone can survive with the debt restructuring and exit of a small country such as Greece or Portugal, not major economies such as Italy and/or Spain. Unfortunately this slow-motion train wreck is now increasingly likely. Only if the ECB became an unlimited lender of last resort and cut policy rates to zero, combined with a fall in the value of the euro to parity with the dollar, plus a fiscal stimulus in Germany and the eurozone core while the periphery implements austerity, could we perhaps stop the upcoming disaster. Read more

Greece is stuck in a vicious cycle of insolvency, low competitiveness and ever-deepening depression. Exacerbated by a draconian fiscal austerity, its public debt is heading towards 200 per cent of gross domestic product. To escape, Greece must now begin an orderly default, voluntarily exit the eurozone and return to the drachma.

Of course, this process will be traumatic. The most significant problem would be capital losses for core eurozone financial institutions. Overnight, the foreign euro liabilities of Greece’s government, banks and firms would surge. Yet these problems can be overcome. Argentina did so in 2001, when it “pesified” its dollar debts. America actually did something similar too, in 1933 when it depreciated the dollar by 69 per cent and repealed the gold clause. A similar unilateral “drachmatization” of euro debts would be necessary and unavoidable. Read more

The muddle-through approach to the eurozone crisis has failed to resolve the fundamental problems of economic and competitiveness divergence within the union. If this continues the euro will move towards disorderly debt workouts, and eventually a break-up of the monetary union itself, as some of the weaker members crash out.

The Economic and Monetary Union never fully satisfied the conditions for an optimal currency area. Instead its leaders hoped that their lack of monetary, fiscal and exchange rate policies would in turn see an acceleration of structural reforms. These, it was hoped, would see productivity and growth rates converge. The reality turned out to be different. Read more

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